Medicaid Savings Ideas – Prescription Drugs



June 21, 2005

Medicaid Savings Ideas – Prescription Drugs

The 2006 federal budget includes $10 billion in spending reductions in Medicaid. Finding reductions of that level—and not cutting critical services for the millions of Americans who rely on the program—will be challenging. There is, however, one area where most agree some savings can be found without reducing services essential to those with Medicaid. That is the area of prescription drug spending. There is widespread agreement that Medicaid pays too much for prescriptions drugs.

This document outlines select approaches that, if pursued, could reduce Medicaid spending on prescription drugs. Savings estimates for some of these approaches are significant. This is not an exhaustive list. The focus is on strategies that would produce the greatest potential savings with the least potential reduction in beneficiaries’ services.

In addition to outlining several cost-saving approaches, this document includes savings estimates for each approach. The savings estimates are based on data available through other sources as well as other budget projections, literature reviews, and the experience of state Medicaid plans that have implemented some of these approaches. Actual CBO scores will likely differ. The estimates are also specific to each approach. Because of the way that the various strategies outlined interrelate, if multiple approaches are pursued, total savings may be less than the sum of the approaches.

Each approach is described below. At the end of this document is a table summarizing the options described.

Strategy 1: Restructuring Pharmacists’ Reimbursement

Background on Pharmacists’ Reimbursement

States have latitude in setting the amount that they will pay for prescription drugs in the Medicaid program; however, there is a maximum payment amount for which a state will receive a federal match. For brand-name drugs still under patent or that have no generic substitute, the maximum is the lesser of (1) the drug’s estimated acquisition cost (EAC) plus a dispensing fee paid to the pharmacy, or (2) the provider’s/pharmacy’s usual and customary charge (UCC). States use a formula to set the EAC, and that formula can vary from state to state. Most states base EAC on the drug manufacturer’s published Average Wholesale Price (AWP) minus a specified percent—usually between 10 and 15 percent.

For drugs that have multiple sources (sold by at least two to three manufacturers—which would include generic drugs), state Medicaid reimbursement is subject to the “federal upper limit” (FUL). The FUL is 150 percent of the lowest published price from any compendia for biologically and therapeutically equivalent drugs. CMS sets the FUL; there are some multi-source drugs that have not been assigned an FUL price. States have the latitude to set more aggressive upper payment limits. Several states set maximum allowable cost (MAC) for multi-source drugs, and many states include drugs on their MAC price list that don’t yet have a federal upper limit calculated. About 40 states have MAC pricing in place.[1] States add a dispensing fee payment.

Rationale for Changing Pharmacists’ Reimbursement

The current reimbursement system (1) results in different prices being paid for the same product from state to state and (2) probable overpayments because payments based on published prices may be considerably higher than pharmacists’ acquisition costs. For example, the Office of the Inspector General (OIG) has found that AWP overstates the acquisition cost of single source drugs (brand-name drugs) by 17.2 percent. For payment based on usual and customary charges (an estimated 25 percent of Medicaid pharmacy claims are paid this way), UCC can vary widely. The amount paid by states for a single drug varies tremendously, even among states using the same reimbursement formula.

Changes should: standardize reimbursement; link reimbursement more closely to actual amounts paid, which should result in savings to Medicaid; and, avoid creating incentives to prescribe brands over generics.

Suggested Approach

Base pharmacy payments on average sales price (ASP)—the weighted average of all non-federal sales prices to all purchasers, excluding sales exempt from the best price calculations,[2] net of rebates, discounts, and other price concessions. However, pharmacy dispensing fees should be set at a flat rate, not based on a percent of the product’s cost (as suggested in some proposals). A percent- based fee would give pharmacists more payments when they dispense higher-priced brands, and might thereby reduce pharmacists’ inclination to educate patients about generic availability and to suggest generic substitution.

The savings estimate is $5.219 billion over five years, which is very close to OMB’s $5.4 figure for this change. CBO’s score may be lower because states are continually moving to more aggressive Medicaid pricing and implementation of MAC pricing systems. A potential negative for patients could be a move on the part of pharmacists to be more aggressive in collecting copayments, refusing to serve individuals who can’t meet copayments, or lobbying for laws allowing them to deny services in states where such laws aren’t currently on the books.

Strategy 2: Change Rebate Calculations to Increase the Minimum Rebate

Background on the Rebate System

As a requirement for participation in Medicaid, manufacturers must provide a rebate on Medicaid sales. Rebates are calculated quarterly, based on states’ sales. For brand-name drugs, the rebate is equal to the maximum of (1) a fixed percent of the Average Manufacturers Price (AMP)—currently 15.1 percent—or (2) the difference between the AMP and the manufacturer’s “best price.” A drug’s AMP is the average price a drug wholesaler pays a manufacturer for retail distribution. AMP excludes direct sales to HMOs and hospitals, Federal Supply Schedule, and 340(b) prices. AMP is not publicly available, and the GAO has found “considerable variation in the methods that manufacturers use to determine AMP” (see GAO-05-102, Medicaid Drug Rebate Program: Inadequate Oversight Raises Concerns About Rebates Paid to States, February 2005, and Option 3, below). “Best price” is the lowest price paid by any non-federal purchaser. “Best price” calculations exclude sales to the VA, DoD, and state pharmacy assistance programs. The Indian Health Service; Federal Supply Schedule prices; and sales at a nominal price. An additional rebate applies if the AMP grows faster than inflation. Generic drug manufacturers must rebate 11 percent of the AMP.

Because manufacturers frequently give purchasers discounts greater than the minimum rebate (AMP-15.1 percent) for many drugs, the Medicaid rebate is based on “best price.” CBO has reported that overall, Medicaid receives an average basic rebate from manufacturers of about 22 percent of the AMP. This does not include the additional rebate tied to price inflation. (See CBO Budget Options, February 2005; and, Prices for Brand-Name Drugs Under Selected Federal Programs, June 2005.)

Rationale for Changing the Rebate System

Medicaid is a large purchaser. As a result, manufacturers set prices to private payers with Medicaid implications in mind. Some manufacturers may, as a practice, try to limit private payer discounts because of best price implications. By limiting price reductions to private payers, manufacturers in turn limit rebates to Medicaid. Some states have been able to use their purchasing clout to negotiate supplemental rebates. The ability of state Medicaid programs to exert negotiating clout to obtain additional rebates may decline in 2006 when Medicare’s prescription drug benefit begins. At that time, the responsibility for covering drug costs for individuals eligible for both Medicaid and Medicare—a group that accounts for about half of Medicaid’s drug spending—shifts to the Medicare program. This will greatly reduce state’s negotiating leverage with manufacturers.

Increasing the flat rebate—the 15.1 percent off AMP—would raise the average rebate. CBO has estimated that increasing the minimum rebate to AMP- 20 percent (retaining the best price provision), would raise the average rebate off AMP to 23 percent and provide estimated savings of $3.2 billion through 2010 (see below). The basic rebate would be greater than AMP-20 percent because some drug rebates would continue to be based on best price. The provision for additional rebates based on price inflation would also remain. Beyond providing savings to Medicaid, increasing the minimum rebate might result in private payers being able to negotiate deeper discounts. It would also provide some protection for states that might not be able to retain the supplemental rebate levels they have negotiated when the Medicare drug benefit begins.

This approach does not include doing away with the “best price system” and totally replacing it with a flat rebate system because manufacturers have proven very adept at price manipulation. A price system that does not take into consideration prices paid by other purchasers could, over time, result in Medicaid paying among the highest price of all purchasers. Including a requirement that manufacturers continue to report prices will help guard against Medicaid overpaying compared to other purchasers.[3]

Suggested Approach Increase the flat percent portion of the calculation to AMP-20 percent (or higher, AMP-25 percent). The brand drug rebate would be based on the lower of the set percent off AMP or the best price; include a comparable increase for generics.

Estimated savings are $3.2 billion over five years based on CBO’s score for raising the minimum flat rebate from 15.1 percent to 20 percent (see CBO’s Budget Options, February 2005). Of note, a recent Lewin Group/AHA report estimates this approach would result in savings of $6.1 billion over five years. The savings difference with each percent increase in the flat rebate amount over 20 percent would be considerable.

We do not foresee any negative impact on beneficiaries from this approach. The industry lobby would be staunchly opposed to anything other than a budget neutral adjustment to rebate calculations.

Strategy 3: Strengthen Rebate Program Administration

Current Program Administration

GAO’s report, Medicaid Drug Rebate Program: Inadequate Oversight Raises Concerns About Rebates Paid to States, February 2005 (GAO-05-102), reviewed CMS’s Medicaid rebate program administration. It found inconsistent guidance, poor reporting on price concessions, and erratic audits. Examples GAO cited include:

▪ Failure of CMS to provide clear guidance to manufactures for determining AMP;

▪ Limited review of prices by CMS with review of price determination methods only when manufacturers request recalculation of prior rebates;

▪ Failure of CMS to provide guidance addressing treatment of price concessions that PBMs negotiate on behalf of third-party payers, such as employer-sponsored plans, in calculating AMP.

Adequate oversight and guidance is essential to ensuring that the Medicaid program receives appropriate rebates. Poor oversight raises concerns that rebate payments by manufacturers have been, and continue to be, inadequate under current law. Further, GOA noted that CMS’s failure to issue clear guidance has hampered OIG’s ability to audit manufacturers’ methods for price calculations. GAO recommended several improvements to program management, which would result in savings to Medicaid.

Rationale for Strengthening Administration

Given GAO’s findings, rebate program administration should be tightened. This should occur regardless of other changes to program payments.

Suggested Approach

Address flaws, poor management, and inconsistencies noted in the GAO report. An OIG review of program administration estimated potential savings from tighter management could be from $1.6 to $3.2 billion over five years, with the low end of the estimate most achievable.

We do not foresee any negative impacts on beneficiaries from this approach.

Each of the approaches outlined is summarized in the attached table. Additional approaches considered, but not elaborated in this document, are listed below.

Possible Medicaid Savings Approaches Prescription Drugs

NOTE: Savings estimates are for each approach individually. They are not cumulative.

|Approach/Description |Estimated Savings |Beneficiary Impact |

| |and Rationale | |

| |(5 year Savings Unless Noted) | |

|1. Restructure Pharmacists’ Reimbursement. |$5.219 billion over 5 years |This will result in a reduction in Medicaid |

|Reimburse pharmacists based on Average Sales |(very similar to OMB’s $5.4 figure) |payments to pharmacists. As a result, |

|Price + a dispensing fee (fixed dollar amount for| |pharmacists may be more aggressive in |

|fee). | |collecting copayments from Medicaid |

| | |beneficiaries or in pushing for legislation |

| | |allowing them to refuse dispensing for |

| | |non-payment of copayments. |

|2. Change rebate calculation. Change rebate |$3.2 billion over 5 years |None. |

|calculations in a way that increases Medicaid | | |

|savings and opens opportunities for private |(Based on CBO’s score of raising minimum |Governors April 15, 2005 draft memo supports |

|payers to get larger discounts. Suggest raising |flat rebate from 15.1% to 20%, see CBO’s |the idea of additional rebates |

|the flat rebate portion of the calculation (the |February’s Budget Options; a Lewin | |

|minimum rebate amount) for brand drugs from 15.1%|Group/AHA report estimates savings at $6.1| |

|to 20% (or higher) and retaining the best price |billion over 5 years.) | |

|provision and provision for additional rebates | | |

|linked to drug price inflation. Comparable rebate| | |

|increase for generics. | | |

|3. Strengthen rebate administration. GAO has |$1.6 to $3.2 billion over 5 years |None |

|criticized rebate program administration as lax. | | |

|Any reforms should incorporate improvements in |An estimate of 2.5 to 4% savings based on | |

|program administration. |OIG assessment of current program | |

| |administration. | |

For more information, contact Dee Mahan at Families USA.

Phone: 202-628-3030 E-mail: dmahan@

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[1] Medicaid’s Reimbursement to Pharmacies for Prescription Drugs, Congressional Budget Office (Washington: December 2004).

[2] Sales excluded from Medicaid’s best price calculation are sales to federal purchasers (VA, DoD, Indian Health Service, etc.), state pharmacy assistance programs, the federal supply schedule prices, and sales that are at a nominal price.

[3] The Administration is proposing a “budget neutral” change to the rebate program, doing away with best price and using a flat rebate (details on the rebate calculation are unclear at this time). One result of that could be larger discounts for private payers (as manufacturers no longer need to consider Medicaid impact in pricing calculations) and Medicaid—with a set rebate—eventually paying among the highest prices for prescription drugs.

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